Time Well Spent; Unchanged Catalysts to Consolidation; and Concerns Surrounding the Delta – Northwest Deal

Time Well Spent

A significant amount of my career has been spent participating in labor negotiations surrounding a distressed situation. There are two principles I always adhered to when advising clients: 1) you can always make a bad deal; and 2) strive to make a deal where either both sides are happy or both sides are unhappy because in both scenarios that probably means you have negotiated the best deal possible. Trying to avoid a scenario where one side is happy and the other side unhappy means you have negotiated a bad deal – and that is precisely what Northwest and Delta are trying to avoid.

Justin Baer of the Financial Times writes an excellent piece describing why seniority is critical for pilots. So it is important to understand just why these discussions are taking so long. Given that we are more than 20 years from the US industry’s last round of consolidation involving multiple carriers, pilots recognize that decisions made today will more than likely impact the majority of their remaining careers. But the always thoughtful and insightful Liz Fedor of the Minneapolis Star Tribune raises the specter of a negotiating clock. Another important negotiating rule is that it is hard to negotiate without a deadline.

Whereas many journalists and pundits are suggesting that the end is near in these negotiations, and as a result the much discussed deal will die, I am not one of them. Ms. Fedor in her opening paragraph writes: “A veil of silence has encircled the pilot leaders at Delta Air Lines and Northwest Airlines who are struggling to integrate their seniority lists -- the lone impediment to a merger announcement”. So why is this important? I typically read no talking as a positive sign. And the only people I have heard say Hell No to this deal before seeing the details is Congressman Jim “Hell NO”berstar and members of his staff.

I am an open proponent of change. I am an opponent of closed mindedness. One of the big points that I think is being missed: if there is concern over a political clock running out to get regulatory approval, then weeks spent today could possibly save months gaining regulatory approval for the deal tomorrow. In concluding her piece, Ms. Fedor raises this very important point that I have not seen written elsewhere as well: “If an agreement is negotiated in advance of a merger announcement, the two pilot groups also would be expected to be political allies for a merger during a regulatory review in Washington”.

The Catalysts to Consolidation Remain Unchanged

This morning, William Greene, analyst at Morgan Stanley writes a research note referencing the widely covered internal Delta memo to employees yesterday. The text of Mr. Greene’s note follows:

Delta Air Lines, Inc.
Quick Comment: CEO Memo Does Not Change Our Views

Impact on our views: The Delta CEO memo made public on Tuesday highlights the difficulties involved in completing airline mergers. That said, we still believe a deal is possible near-term for 2 reasons: (1) Oil prices at $100/bbl and a slowing US economy will keep the pressure on major airlines “to do a deal” and (2) the very substantial pay increases and equity ownership that labor stands to receive should a deal happen will increasingly put pressure on labor leaders to find common ground on seniority issues. Moreover, the economic arguments supporting consolidation are as compelling today (if not more so given the macro backdrop) as they were 6-12 months ago.

What's new: On Tuesday, Delta released a memo from CEO Richard Anderson to employees that outlined guiding principles for Delta in the event of a merger. The memo is intended to allay concerns that Delta employees have regarding a merger. Key concerns for employees include: seniority, job security, career growth and maintaining pensions. The memo indicates that any deal must satisfy these key concerns and a deal that does has not yet been attained (see memo on next page for more details).

Investment thesis: We maintain an Overweight-V rating on DAL primarily due to the company’s positive stance toward consolidation and good position vis-à-vis our key themes (market exposure, strategic actions, and labor risk). We also see relative value in DAL, although we note that we see the group as a whole as overvalued on an absolute basis at current oil prices. This is one reason we continue to recommend that investors sell into strength on news of consolidation. Should the stock run sharply higher from current levels or if the outlook for consolidation changes dramatically, we may need to revisit our rating.

Concerns – And Yes I Have Some

In a post earlier this month, I asked the following question regarding a labor leader’s decision making whether to support a deal or not: is the implementation risk of a merger deal (seniority integration, single collective bargaining agreement etc.) any greater than a leader having to manage the expectations of any employee group that actually believes they can make themselves whole in the next round of Section 6 negotiations?

While I understand the Northwest pilots are not prepared to sign on just because they would work under Delta rates of pay on the day following consummation of a deal. But doesn’t the question beg, as far as career earnings are concerned, just how much would pilots earn at Northwest if the company were to remain a stand alone entity? What are Northwest’s 20 year growth prospects? Will Northwest be able to duplicate organically what it would get fairly quickly in a deal with Delta? Will labor have any better opportunity over the next 5 years to do any better by their members?

Only the Northwest MEC can answer these questions. Where I am concerned is that the Northwest MEC is being advised by counsel in the Northwest – Republic seniority integration and in the most recent US Airways – America West pilot seniority integration (also reported by Ms. Fedor). By now everyone is aware that there are few, if any, success stories in either of these two cases. I just hope that decision making is not being clouded by the prospect that somehow past wrongs can be righted through this deal. But only those that know, know.

So hopefully either all will be happy or all will be unhappy. Otherwise just go ahead and say "Hell No". At least someone will be happy.

Pondering a Delta – Northwest Merger Yet Again: Irony and Sad Irony

Review of the Catalysts

On February 18, 2008, Justin Baer of the Financial Times wrote a very good – must read - story outlining the catalysts underlying the US industry’s current move to consolidate. More importantly he provided the historical context as to why then was not right for Delta and why now is right. In the face of $100 oil, Mr. Baer reminds us that the industry is still susceptible to economic cycles. As the US economy struggles we now hear stories of its effect – potential effect - on the European economy.

I raise the issue of non-US economic activity because the current consolidation environment is every bit about the ability to address the fragmentation of the US domestic market as it is to position US airlines carrying the US flag around the world to be strong global players again. Economies of scope, scale and density are certainly important in the domestic market but will prove essential in the global market as competition from known competition increases.

But more importantly, it is the competition from the unknown competitors that requires the US industry to address its weaknesses today or face a continued loss of global market presence tomorrow. In the article he writes of the various stakeholders – labor, Oberstar, low cost carriers – and their respective views on change.

Irony #1

Yesterday, MSN's MoneyCentral ran a piece entitled: “$100 oil may just be the beginning”. Isn’t it ironic as we await word from the pilots that the number 1 catalyst for the industry to seriously consider consolidation - oil prices - oil closes above $100 per barrel for the first time? Remember when United and others suggested that oil at this level, and if sustained, would cause each carrier to evaluate the possibility of reducing capacity?

Consolidation more than likely results in a better outcome for communities of all sizes than does an oil environment that renders some markets not economic to serve. In no consolidation scenario being discussed are there markets that would be disenfranchised from the air transportation system. This is because network efficiencies can be found to maximize revenue – or to minimize the loss of continuing to serve marginal markets. Fewer frequencies is a much better outcome than outright exit from currently serving a market.

So rather than fear the loss of service due to consolidation, the alternative of losing service due to changed economic condition – whether oil or economy-driven - is every bit as great, if not greater. Something to consider for the naysayers.

Irony #2

Liz Fedor of the Minneapolis Star-Tribune writes about the issues facing the pilots of each Northwest and Delta on the difficulties of negotiating the workings of a merged seniority list. I am one who believes that time spent negotiating these details today will result in significant time saved tomorrow in getting the deal approved when the transaction in its entirety is scrutinized by the regulators, Congress and the various publics that will opine.

Irony #2a – Sad Irony

Whereas yesterday many stories ran regarding the status of the pilot negotiations at Northwest and Delta, the National Mediation Board approved the application of the US Airline Pilots Association (USAPA) to conduct an election for representation of the former US Airways and America West pilots. Why is this ironical and sad to boot? Because this is precisely what the management and labor at each Northwest and Delta are trying to avoid.

Merger synergies typically need to be captured early in the deal. US Airways realized immediate revenue line benefits of combining their two networks. But until these labor issues are concluded, synergies on the cost side are muted, if not mitigated. So the nation’s smallest network carrier just keeps getting smaller and the upside for its pilots will keep getting less and less. I agree with Captain Prater that this decision is emotional and not rational and does nothing to move the ball forward for either the pilots or the combined companies.

The USAPA is making promises it cannot keep. And that is why it is well worth waiting for the two labor parties at Delta and Northwest to come together. The wait is worth it for all involved.

And besides, is the anticipation of a final deal really any different than any other negotiation that takes place routinely in this industry?

Pondering A Northwest – Delta Combination

A Thought for Today

How does the Northwest/TPG bid for Midwest factor into the various consolidation scenario considerations being explored?

On January 7, 2008, Liz Fedor, airline reporter for the Minneapolis Star Tribune, wrote a story suggesting that the Department of Justice would complete its review of the proposed transaction by January 31, 2008. In the article, Northwest suggests that the transaction is being reviewed by the DOJ much like a merger would be reviewed.

If approved, a Delta – Northwest combination just might receive more intense scrutiny than originally thought. Geographic concentration? I am not going to get too excited given the confluence of hub competition within this region. Or is this yet another reason why a decision regarding Comair – read Cincinnati – is being postponed?

Maybe an AirTran acquisition of Midwest might resurface? In today’s TheStreet.com, Ted Reed reports that PAR Capital has made a passive investment in AirTran. An AirTran/Midwest combination could be the low cost competition lacking in Minneapolis and Milwaukee? Just a thought and yet another example of the myriad of complex network issues that are sure to be scrutinized and considered as this consolidation round gets kicked off.